Does Refinancing a Car Hurt Your Credit?

does refinancing a car hurt your credit

By Donna Freedman
Reviewed by Lauren Bringle, AFC®

Refinancing a car can hurt your credit, for several reasons.

  1. Refinancing means taking on a new loan to pay off your existing car loan.
  2. In order to issue the new loan, the lender will probably make a hard credit inquiry.
  3. The new loan will affect your average age of accounts and credit utilization.

But more on those details in a bit.

If you're at risk of being late or totally unable to repay your existing car loan, then it may be worth the temporary credit score setback that could come with refinancing. Being late or defaulting on the loan will damage your credit score and probably result in more fees and frustrations.

It’s a tricky topic, so we’re taking it step by step to answer the question "does refinancing a car hurt your credit?". Read on or jump ahead using the links below.

Contents

Is it a good idea to refinance a car loan?

Everyone’s financcial situation is unique, but sometimes it really is a good idea to refinance a car loan.

For starters, interest rates can drop. In the third quarter of 2019, new-car loans were at 5.38%; a year later, they were at 4.22%. Used-car loans during that time period went from 9.09% to 8.43%. [1]

So if you bought a car in late 2019 or early 2020, refinancing the original loan could make sense – especially since auto refinance rates as of March 2021 were as low as 1.99% (depending on your credit score).

Some other reasons to refinance a car loan:

  • Your existing loan might be a high-interest car loan. Maybe now you can get better terms because you have better credit or income - or both!
  • You got your loan at the dealership, not knowing that dealers tend to mark up the cost of financing. [2]
  • Your options were limited when you bought the car. Maybe you were in a difficult financial position and getting a bad-credit car loan was the only option.
  • You want to pay the car off early, but the loan has a prepayment penalty.[3] Refinancing into a no-penalty loan could let you make those extra payments and own your car faster.

In cases like these, refinancing could be the right way to go.

How much can you save by refinancing?

According to U.S. News & World Report[4], here are the average auto refinance loan rates by credit score as of February 2021:

  • Excellent credit (750 and up): 2.39%
  • Good credit (700 to 749): 2.39%
  • Fair credit (600 to 699): 2.74%
  • Bad credit (451-599): 7.01%

(Note: These are averages, not guaranteed rates. In addition, lenders use other factors besides your credit score to determine interest rates.)

Borrowers with credit scores of 450 or lower generally have a hard time getting auto loans and will pay a higher interest rate.

But notice the potential interest rate difference between a credit score of 599 (7.01%) and a credit score of 600 (2.74%). With the lower interest rate, you could save thousands of dollars over the course of a 60-month loan depending how much your're financing. Check out the handy myFICO loan savings calculator[5]

Find out what credit score car dealers use.

Do you get money back when you refinance a car?

You can get money back in a car refinancing if you get a cash-out auto refinance loan[6].

Basically, you’re paying off your existing vehicle loan with a bigger loan, and keeping the difference. It’s like a cash-out mortgage refinance in that you’re using the equity in your car to get cash right now.

To qualify, your car has to be worth more than its existing loan balance. Suppose your vehicle is worth $15,000 and your car note has $5,000 left on it. You might be able to get a cash-out auto refinance loan for up to $15,000 and keep the $10,000 difference.

How much you can refinance varies from lender to lender. There’s no guarantee that you’ll get the full value of the car or truck.

While you may get a lower interest rate or a different loan term, the cash-out auto refinance loan will always be bigger than the original loan. That’s because you’re refinancing to get cash back.

Is there a downside to refinancing a car?

There can be downsides to refinancing a car, but there aren't only downsides (more below).

One downside to refinancing could be that you take out a longer loan than the one you have now. That could mean paying more interest overall.

Check lender websites for auto refinance loan calculators to help you determine whether you'll pay more or save money by refinancing.

Note: If you plan to apply for a mortgage or some other big loan within the next year and your credit score isn't already excellent, it’s best not to seek any other new forms of credit[6], including an auto loan refinance.

Applying for and getting a new credit line will probably cause your credit score to drop, even if temporarily. You'll be in a stronger position when talking to a lender if your credit report and credit score are looking their absolute best.

See our related article addressing the question "how fast will a car loan raise my credit score?”.

What are the pros and cons of refinancing your car?

When you’re thinking about refinancing your car, a lower interest rate is one major positive reason to refinance. But there are other good reasons to refinance your car.

Pros of refinancing your car

Lower interest rate. The average new-vehicle loan in the third quarter of 2020 was for $34,635; the average used-car vehicle loan was $21,438[1].

Getting a new loan rate that’s even 1 percentage point lower can make a big difference, especially since the average car loan is 69.68 months for new cars and 65.15 months for used ones.

(You’ll need to keep fees in mind, though; more on that below.)

Debt consolidation. Suppose you have $10,000 in credit card debt. You might be able to get a lower interest rate on a cash-out auto refinance than on a personal loan.

Then you could use the cash you get back from the refinance to pay down that card debt, or even pay it off completely. Since the average credit card interest rate is 16.28% [7] you’d potentially save a lot in interest. (There’s a potential downside to this, however, which we’ll get to in a minute.)

Improved cash flow. Maybe you were already living paycheck-to-paycheck and suddenly the rent went up by $100/month, or the cost of your medication rose sharply. Having a smaller monthly car loan payment can help you keep the household budget balanced.

(To increase your financial resilience, see “7 Tips for Breaking the Cycle of Poverty.”)

Avoiding repossession. If you’re having trouble making your auto loan payments, refinancing could mean a smaller, more affordable car payment.

Even though you’ll pay the new loan for longer (probably six months or more)[8], that’s better than missing payments or having the vehicle repossessed – both of which would really hurt your credit score.

Keeping your car means you can still get to work. And since auto lenders focus on your car-payment history – especially your current vehicle’s payment record [9] – then a repo would make it tough to get a decent loan rate for a replacement vehicle.

Cons of refinancing your car

Longer term. It’s possible that your car debt will be extended by six months or more. That’s probably better than losing the car altogether. Besides, if you get a better interest rate, you could wind up paying less in overall interest.

Fees and/or penalty. Loan origination fees vary, but every lender has them. Some loans also feature prepayment penalties, which means you’ll be charged a fine for paying your loan off early – which includes getting an auto loan refinance.

Generally speaking, a loan longer than 61 months has no prepayment penalty;[10] read your loan agreement to be sure. Add fees and any penalty to the total cost of refinancing, then use an online calculator to see if you’d actually save money with a new loan.

Credit pulls. Lenders will want to check your credit,[8] which could cause a drop in your credit score. (Some lenders do “soft” credit pulls,[10] but most don’t.) These are not big hits to your credit score, however, and their impact generally lasts a year or less[8].

Other credit impacts. A new loan means a change in your length of credit history, which makes up 15% of your credit score. If you choose a cash-out auto refinance loan, the higher amount of the loan will increase your credit utilization; this could be a more serious impact, as credit utilization makes up 30% of your score.

Possible repossession. If you get a cash-out auto refinance loan and use it to pay off that credit card debt, in theory you’d save money because of the lower interest rate. But credit card debt is unsecured debt; the card issuer can charge you interest and penalties, but they can’t take anything away from you if you default.

An auto refinance loan is secured debt – as in, secured by your vehicle. If you stop making payments, your car could be repossessed.

Going upside-down. Suppose you get that cash-out auto refinance loan and the vehicle is stolen, or you have a car crash that totals the vehicle. Your insurance might cover only the cash value of the vehicle – not the balance remaining on the loan.

Guess who has to cover the difference? Learn more about the consequences of long-term auto loans here.

Paying more overall. Refinancing an aging vehicle can mean paying more over the long haul[2]. The vehicle could be out of warranty by the time you finish the loan, which means you’d be paying for major repairs and a car note.

How long should I wait to refinance my car?

You know that old saying about how your brand new car becomes a “used car” the minute you drive it off the lot? Believe it.

Cars depreciate very quickly, losing as much as 20% of their value in the first 12 months that you own them. The younger the car, the more likely it will be a good prospect for an auto refinance loan.

The number of loan payments left matters, too[2]. Refinancing is meant to save you interest, after all. Would you rather save money for four years, or for 18 months?

The bottom line

Each car owner’s situation is unique. You could save some decent money over the life of the current loan by refinancing for a better interest rate.

In some cases, a cash-back auto refinance loan might let you retire some higher-interest personal debt. Refinancing could even mean the difference between keeping the car and losing it to repossession.

But auto loan refinancing isn’t for everyone. Refinancing could cost you more over time, land you upside-down on the loan, or leave you owing money on a car you could no longer drive.

Do the math and determine whether an auto loan refinance is right for your situation. The money you save can boost your future financial goals.

Article Sources

  1. Experian. "Automotive Industry Demonstrates Resilience in Q3 2020" https://www.experian.com/blogs/insights/2020/12/automotive-industry-demonstrates-resilience-in-q3-2020/ - Accessed April 8, 2021
  2. Consumer Reports. "Now May Be the Right Time to Refinance Your Car Loan" https://www.consumerreports.org/car-financing/now-may-be-the-right-time-to-refinance-your-car-loan/ - Accessed April 8, 2021
  3. Capital One. "Should I Refinance My Car Loan?" https://www.capitalone.com/cars/learn/managing-your-money-wisely/should-i-refinance-my-car-loan/1053 - Accessed April 8, 2021
  4. U.S. News & World Report. "Average Auto Loan Rates in February 2021" https://cars.usnews.com/cars-trucks/average-auto-loan-interest-rates - Accessed April 8, 2021
  5. myFICO. "Loan savings calculator". https://www.myfico.com/credit-education/calculators/loan-savings-calculator/ - Accessed April 8, 2021
  6. Experian. "What Is a Cash-Out Auto Refinance?" https://www.experian.com/blogs/ask-experian/what-is-cash-out-auto-refinance/ - Accessed April 8, 2021
  7. Federal Reserve Bank of St. Louis. "Commercial Bank Interest Rates on Credit Card Plans" https://fred.stlouisfed.org/series/TERMCBCCINTNS - Acccessed April 8, 2021
  8. Experian. "Will Refinancing My Auto Loan Hurt My Credit Score?" https://www.experian.com/blogs/ask-experian/will-refinancing-my-auto-loan-hurt-my-credit-score/ - Accessed April 8, 2021
  9. Edmunds. "How to Buy a Car After Bankrupcy" https://www.edmunds.com/car-loan/how-to-buy-a-car-after-bankruptcy.html - Accessed April 8, 2021
  10. Edmunds. "How to Get Out of a Bad Car Loan" https://www.edmunds.com/car-loan/how-to-get-out-of-a-bad-car-loan.html - Accessed April 8, 2021

About the author

Longtime personal finance writer Donna Freedman lives and writes in Anchorage, Alaska. See her on Linkedin and Twitter.

About the reviewer

Lauren Bringle is an Accredited Financial Counselor® with Self Financial – a financial technology company with a mission to increase economic inclusion by helping people build credit and savings. Connect with her on Linkedin or Twitter.

Written on April 7, 2021

Self is a venture-backed startup that helps people build credit and savings.
Comments? Questions? Send us a note at hello@self.inc.

Disclaimer: Self is not providing financial advice. The content presented does not reflect the view of the Issuing Banks and is presented for general education and informational purposes only. Please consult with a qualified professional for financial advice.

Ready to join Self?